Professional goodwill includes 'personal goodwill' when it comes to dividing marital assets

An orthodontist who owns his own practice must split the value of his professional goodwill in the business with his ex-wife, and also pay future maintenance based on income derived from the professional goodwill.

July 28, 2011 – Some states divide professional goodwill into two components – “personal goodwill” and “enterprise goodwill” – and exclude personal goodwill from the divisible marital estate at divorce. The Wisconsin Supreme Court recently clarified that Wisconsin isn’t one of them.

In McReath v. McReath, 2011 WI 66 (July 12, 2011), the supreme court unanimously ruled that the entire value of “saleable” professional goodwill is properly counted as divisible marital property, regardless of whether it is characterized as personal or enterprise goodwill.

Timothy and Tracy McReath were married for almost 19 years before Tracy petitioned for divorce in 2007. At the time, Tim was earning an average of almost $700,000 per year (50-70 hour work week) running his own orthodontics business.

He paid $930,000 for the business from another orthodontist, Dr. Grady. A large portion of the purchase price, $830,000 was attributable to a noncompete agreement with Dr. Grady and the transition services he would provide in helping Timothy get the business running.

In divorce proceedings, the Sauk County Circuit Court determined the fair market value of Tim’s business to be $1.058 million – the value offered by Tracy’s valuation expert – and awarded Tracy $796,720 to equalize the property division based on that finding.

The court also awarded Tracy $16,000 per month ($192,000 annually) in maintenance, for 20 years, based on Tim’s expected average annual income for a 40-hour work week.

On appeal, Tim argued that the circuit court should have excluded “personal goodwill” as divisible personal property. He also argued that the circuit court double counted the value of professional goodwill by basing Tracy’s maintenance award on Tim’s expected future earnings.

Saleable goodwill

The supreme court clarified that “saleable” professional goodwill is divisible marital property, and circuit courts need not distinguish between “personal” and “enterprise” goodwill, as some states do do, when dividing the marital estate.

“This is so,” Justice Patience Roggensack wrote, “because the premise on which the distinction is grounded – that enterprise goodwill is saleable and personal goodwill is not – is mistaken.”

Personal goodwill, the court explained, is characterized as the goodwill that is “’attributable to the individual owner’s personal skill, training or reputation,’ i.e., it is the ‘the goodwill that depends on the continued presence of a particular individual,’” citing the Indiana case of Yoon v. Yoon, 711 N.E.2d 1265, 1268 (Ind. 1999).

Also citing Yoon, the court explained that enterprise goodwill is characterized as “’goodwill in a professional practice … attributable to the business enterprise itself by virtue of its existing arrangements with suppliers, customers or others, and its anticipated future customer base due to factors attributable to the business.”

The court noted that Tim testified to paying $830,000 for the professional goodwill established by Dr. Grady, which included elements of personal goodwill like the noncompete agreement and Dr. Grady’s transition services. The court also noted that Tracy helped create Tim’s professional goodwill in the business as it developed over time.

“Therefore, as this case demonstrates, in some situations, personal goodwill is saleable,” Justice Roggensack explained. “Where the saleable professional goodwill is developed during the marriage, it defies the presumption of equality to exclude it from the divisible marital estate.”

However, professional goodwill won’t always be “saleable,” the court explained, noting Holbrook v. Holbrook, 103 Wis. 2d 327, 209 N.W.2d 343 (Ct. App. 1981). And in those situations, “professional goodwill is not part of the divisible marital estate.”

In Holbrook, the appeals court found that a law firm partner’s interest in the law firm was not saleable, and thus not part of the divisible marital estate, because ethical and contractual considerations prevented the law partner from selling his interest on the open market.

Double counting

The supreme court also rejected Tim’s argument that the circuit court “double counted” the value of his professional goodwill by basing Tracy’s maintenance award of $16,000 per month on Tim’s expected future earnings.

Tim argued that his future earnings were partially based on professional goodwill and Tracy already obtained half the value of Tim’s professional goodwill in the business.

Noting that double counting is prohibited in pension-type situations, the court leaned on Hommel v. Hommel, 162 Wis. 2d 782, 471 N.W.2d 1 (1991) to conclude that the double counting rule is not violated when investment income from an asset is included in a maintenance award, even though the asset is divisible marital property.

“The saleable professional goodwill in [Tim’s business] is similar to asset that produces income,” the court explained. Thus, the supreme court concluded that the circuit court did not double count the professional good will in making the monthly maintenance award.